As of 2015, approximately 15 million Americans were self-employed, about 10.1 percent of the working population. This is a very significant number of people. For many, working for themselves is a lifelong dream—to be free of bosses, office routines, irritating coworkers . . . The thought of working out of your home and deciding your own hours and work goals is enormously attractive to many people.
However, Social Security can present concerns, and even shocks, to self-employed people. The fact is that although you work for yourself, you haven’t opted out of U.S. government-administered systems. And that means you will pay taxes.
In some ways, your tax situation as a self-employed person is far more complicated than if you worked for a company. For one thing, the company arranges for your taxes to be automatically deducted from your paycheck every fortnight (or however often you’re paid). However, as your own boss you are now responsible for making sure that your taxes are paid—including the payroll taxes that fund Social Security and Medicare. If you earn more than $400 a year, you must file tax Schedule SE (in addition to other forms).
If you work for an employer, matters regarding the Social Security tax are pretty simple. You pay 6.2 percent, and your employer pays 6.2 percent for Social Security; and both you and your employer pay the 1.45 percent tax to fund Medicare. However, if you’re self-employed, the government assumes that you are both employer and employed. You have to pay both halves of the tax: 12.4 percent for Social Security and 2.9 percent for Medicare. That suddenly doubled tax burden can come as a shock—particularly in the early days of your self-employed career when your income isn’t all that large and you’re scrambling to find new gigs.
The good news is that you’re allowed to take some deductions you wouldn’t be permitted if you worked for someone else. For example:
If you have both wages paid by an employer and self-employment earnings, and if they total more than $118,500, you must pay taxes on the wages first. For example, if Roger earns $75,000 from his job and in addition makes $50,000 in freelance work from his self-employment business, his employer will withhold taxes on his wages. Roger will pay Social Security and Medicare on $43,500 ($118,500 – $43,500 = $75,000) and will pay Medicare on the remaining $6,500 ($125,000 – $6,500 = $118,500).
For purposes of figuring your net earnings, Social Security counts your gross earnings minus allowable business deductions and depreciation. When figuring your net earnings from your business, you should not include:
If you’re in the early stages of your self-employment, it is possible that your net earnings will fall below $400. However, you can still count this for Social Security purposes. Here’s how the SSA explains it:
You’re only allowed to use this optional method five times in your life except if you’re a farmer. If you are, you can use this method every year, and you don’t have to have earned at least $400 the previous year.
You can find additional information about the optional method of reporting in the IRS’s Tax Guide for Small Business, located online at www.irs.gov/pub/irs-pdf/p334.pdf.
In any year in which your business earns $400 or more in net earnings, you need to fill out the following IRS forms: